Solar, The Investment Tax Credit – Part 2

Welcome back! Thanks for joining me for Part 2 of our look at the Investment Tax Credit (ITC) for solar property. In Part 1, I gave an overview on the history and purpose of the solar ITC. I also discussed some of the tax benefits available to eligible solar projects. Part 2 will focus on items that can reduce or delay the tax benefits discussed in Part 1. These items should be taken into consideration when evaluating an investment in commercial solar.

What items can affect the tax benefits from solar projects?

Depreciation:
Bonus depreciation is scheduled to be phased out by 2027. The applicable percentage will be reduced by 20% each year starting in 2023. Going forward, the ability to recover the solar project cost in year 1 with bonus depreciation will not be possible unless Congress acts and restores the 100% deduction.

Section 179 depreciation expensing has various thresholds in its own right that may limit how much Section 179 you can take in a tax year.

The depreciation expense will not be lost but may need to be recovered over multiple years versus the year the project is placed in-service as it has been in recent years.

Credit Recapture:
The solar project entity or taxpayer may be subject to credit recapture if the project or taxpayers’ investment in the solar project is disposed of within five years of the solar project being placed in-service.

Tax Basis & At-Risk Limitations:
Due to the large scope of solar projects, the amount of depreciation taken in the year placed in-service can create a loss. The ability of a taxpayer to deduct a loss in any year on their tax return is determined by their tax basis and at-risk interest. The tax basis and at-risk calculations are complex and are not addressed in this blog.

Passive Activity Rules of IRC Section 469:
Even if you get by the tax basis and at-risk limitations, you may be limited in the amount of losses you can deduct on your tax return. The passive activity rules may limit or even prevent you from deducting losses in a current year. The losses are not forfeited but carryforward to future years. The passive activity rules and deductible passive losses are re-evaluated each tax year.

• The taxpayer must meet one of the seven material participation tests outlined in IRC Section 469 to avoid being considered passive in the trade or business activity.
• If the solar project is determined to be a rental activity, the material participation tests mentioned above will not keep the project from being a passive activity. All rental activities are deemed passive.
• These passive activity rules can also limit the use of the tax credits from the solar project.

Business Loss Limitations of IRC Section 461:
A noncorporate taxpayer has one more limitation that may limit the amount of losses that can be deducted on their tax return in any given year. These are the limitations imposed by IRC Section 461. The maximum allowed deduction in 2023 is $540,000 for joint filers and $270,000 for all other filers. These thresholds are adjusted for inflation in future years. Any business loss that exceeds these thresholds in carryforward to future years as a net operation loss.

State Limitations:
Each state has their own set of tax laws. Some states fully conform to Federal tax laws and some states may choose to decouple (not conform) to certain Federal tax laws. The more common state nonconformity items that pertain to solar projects are:

• Bonus Depreciation
• Section 179 Expensing
• Section 461 Business Loss Limitations
• NOL Deductions

These state nonconformity items usually extend the years needed to recover the deduction. As an example, a state may not conform to Federal bonus depreciation. Instead of getting the full deduction in year one, the state may force you to recover the depreciation over five years.

None of these items should keep you from realizing the tax benefits related to solar projects. They may force the benefits discussed in Part 1 to be utilized in future years and not necessarily all in year one.

The impact of the tax benefit(s) and any limitations that may impact a taxpayer should not be considered in a vacuum. Many of these items are inter-related and depend on complex calculations and working knowledge of tax regulations surrounding solar investment tax credits.

The experts at Mahoney | CPAs and Advisors are here to help you navigate the complex world of solar ITCs. Please contact an experienced tax professional at our firm.

By Brent Buchman
Associate Director – Tax